Market watchdog Sebi recently came out with new guidelines for liquid funds. The newly introduced norms could potentially change the portfolio orientation of liquid funds.
Let’s analyse the impact of these norms from the investor’s perspective:
1. 20% in liquid assets
Firstly, liquid funds need to invest at least 20% of their portfolio in liquid assets such as cash and other government-issued securities like G-secs, T-bills or Repos (on G-secs). This move aims to avoid a repeat of the NBFC related liquidity crisis that some mutual fund houses faced.
Investors can look forward to liquid funds, with much lower liquidity risk. Investing more into cash equivalents could slightly impact returns. It is worth it though, as liquidity is paramount.
Note that, prior to this, the top liquid funds used to have an average exposure of 11% of their portfolio in G-secs. This move may not have a material impact on overall returns.
2. Sector cap reduced from 25% to 20%
Liquid funds will have to contain exposure in a single sector to 20% (25% earlier). It will reduce concentration risk through more diversification. Additional exposure to Housing Finance Companies, of 15%, has also been tweaked in favour of securitised retail housing loan assets. Default rates are relatively lower in the latter.
Valuation based on amortisation has been done away with in favour of mark-to-market. Mark-to-market values debt securities based on daily market prices as against pricing ‘smoothly’ across the tenure. For instance, if you are purchasing an instrument for Rs 99.25 which matures to Rs 100 in 30 days, you earn Rs 0.75 over the month. This was amortised over 30 days by adding 2.5 paisa daily to the value of the instrument.
Under the new mark-to-market norms, prices of debt instruments will be linked to daily market prices, which in turn will change based on ruling interest rates in the economy. This might make NAV of liquid funds little wobbly. This will, however, truly reflect portfolio value. Investor interest is protected from short-term opportunistic flows into the fund.
Liquid funds will have to contain exposure in a single sector to 20% (25% earlier). It will reduce concentration risk through more diversification.
4. Exit loads for less than 7 days
A graded exit load has been introduced for investors exiting the fund within a week. It will detract very short-term corporate investors, while making liquidity management easier for fund managers.
5. Listed securities
It’s now mandatory to invest only in listed bonds – be it Non-Convertible debentures or Commercial Papers. Listed bonds have to follow listing guidelines, by getting them rated and ensuring other compliance and disclosures. This improves portfolio safety.
6. No exposure to Credit Enhancements
Credit enhancements reduce the default risk of the company’s debt through promoter guarantees and share collaterals. Banning exposure to debt instruments having credit enhancements, will lower credit risk in the portfolio. This should ensure that investments go towards safer debt avenues. While returns could be lowered marginally, these risky investments are unwarranted and best avoided for liquid funds.
As and when the above Sebi norms are enforced, liquid funds will become more diversified and safer for investors. Of course, there will be some winners and losers. But you, the investor, should look forward to this.